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Going Activist in Japan - [Business Breakdowns, EP.185]
Business Breakdowns
Deep Dive
Why is activism in Japan becoming an interesting investment strategy?
Japan's equity market is historically undervalued, with 40% of listed companies trading at a price-to-book ratio below 1.0% and 45-50% trading below six times EV to EBITDA. The government's push for corporate governance reforms and the Tokyo Stock Exchange's efforts to improve market efficiency and shareholder value create a compelling opportunity set.
What cultural dynamics contribute to the undervaluation of Japanese equities?
Japan has been in a deflationary environment for decades, leading companies to hoard cash rather than invest in growth. Management teams lack financial literacy and are not incentivized by equity compensation, leading to poor capital allocation and low return on equity (ROE).
How has corporate governance in Japan evolved to support activism?
Corporate governance reform began in 2015, requiring more independent directors and improving transparency. The Tokyo Stock Exchange (TSE) now requests companies to analyze return on equity, return on investor capital, price to book ratio, and weighted average cost of capital, providing a common ground for discussions on stock price improvement.
What challenges do activists face in engaging with Japanese companies?
Japanese companies are often protected by cross-shareholdings, making it easier to ignore minority shareholders. Historically, there was no market for control, and hostile takeovers were frowned upon. However, recent changes in M&A guidelines now allow for hostile bids and have seen an increase in such transactions.
Why are small to mid-cap companies in Japan particularly attractive for activism?
Small to mid-cap companies trade at very cheap valuations, often below six times EV to EBITDA. The TSE's reform to eliminate inefficient companies and the new M&A guidelines that require independent committees to consider bids create opportunities for activism and potential buyouts.
How do management buyouts (MBOs) in Japan differ from those in the U.S.?
In Japan, MBOs can be financed at very low interest rates (3% up to six times net debt to EBITDA) with minimal equity contribution from management. This is due to the abundance of cash on corporate balance sheets and the deflationary environment, which makes financing cheaper and more attractive.
What was the outcome of the Mitsuboshi Belting case and why did it succeed?
Mitsuboshi Belting, a rubber belt company, turned down a buyback proposal but later implemented a 100% dividend payout ratio, doubling its stock price. The company was convinced by the proposal's logic and the potential to improve return on equity (ROE), leading to a significant stock price increase.
How did the Ihara Science case result in a management buyout?
Ihara Science, a valve producer, was approached with a proposal to go private due to its excellent business performance but lack of shareholder returns. The 85-year-old chairman agreed, and the company was taken private at a price close to the activist's proposal, supported by the activist's agreement to tender shares.
What is the current outlook for activism in Japan and its potential for growth?
Activism in Japan is still in its early innings, with valuations re-rating but still significantly below global comparables. The market for control is evolving, and there are many undervalued companies yet to be targeted. The environment is favorable with low financing costs and a growing number of activists entering the market.
Shownotes Transcript